Finance with Don Fraser Fraser Farm Finance

The previous article looked at the advantages of smaller dairy farms being leased to the neighbour because of the lack of economy of scale, compliance costs and so on. The article included discussion around the sale of cows and shares to repay the debt.

The numbers were 70ha producing 70,000kgMS could be leased for say 1300/ha giving a gross income of $91,000 with virtually no outgoings, which is a lot more than you can make by actively farming it I would have thought.

Percentage leasing

This tenure of leasing for a percentage of the dairy cheque has caught on like wildfire. How it works is the tenant get 78 per cent to run the farm and pays all outgoings. The landlord gets 22 per cent of the milk price by way of dairy order paid by Fonterra at source, and pays for very little.

The advantage of percentage leasing is the lessee and the lessor share in all the ups and downs of the industry. The lease document does set out a minimum rental and minimum cow numbers to avoid any issues with downsizing of herds etc.

I prefer to use the Federated Farmers’ Farm Lease agreement, which is the industry standard and has apparently never been challenged in court.

There are many additional issues that must be covered off in the lease. 

For example: Soil tests to reflect nutrient levels that must be maintained; expectations about maintenance of the fences and farm; who pays for ‘capital items’ such as pump replacements; shut up clauses; rights of the owners for access and fruit harvesting; term of lease; effluent disposal; water supply; cropping areas; nitrogen levels; insurance; disputes; health and safety…and the list goes on.

In my opinion percentage leasing is a far better option than 50:50 sharemilking and the reasons are: sharemilkers ‘thought’ that for half the cheque only the owner could pay a lot more costs. Sharemilkers by name did not see themselves as farm maintenance people. There was always a crossover of ‘who’ was the boss. And owners tend to live on the farm and ‘keep control’ and interfere.

Clears doubts

Now I know I’m generalising and 50:50 does work in some cases, particularly with family; but by and large they seem to be problematical.

The percentage leasing gets rid of all those doubts and lack of clear boundaries. The owner can be living in London and still get 22 per cent of the dairy cheque.

Another good feature of percentage leasing is that it can be very long term. The fuss and both goes, the tenant has a long term view and everyone is happy. As a commercial landlord, I could also see that by paralleling dairy farms to long term commercial leasing both the owner and tenant benefited hugely.

Critical mass does come into it however. I think that you really need 100,000kgMS-plus to really make it economic, particularly for the tenant.

The numbers are:

100,000 kgMS x $6 milk price = gross income                            $600,000

Owner:

                22% to the owner                            =                        $132,000

Remember the owner has virtually no outgoings

Tenant

Tenant share 78% to run the business    =                                   $468,000

There are other calculations showing up in the industry but percentage remains the most favoured option.

Interestingly I’ve been talking to an oil and gas consultant and much the same system is used there. Owners of the field get 20 per cent of income and 80 per cent goes to the exploration oil and gas harvester.

Summary

Unashamedly, I’ve got a lot of pleasure out of introducing percentage leasing into the dairy industry. It has morphed and changed but the basics remain the same. It seems better and fairer than 50:50 with a lot less organising and bitterness. It will continue to change and grow to meet the ever-changing tenure needs of the industry.

It does encourage farm land to stay in the family rather than being sold, cashed-up and then where does the money go?

Disclaimer – These are the opinions of Don Fraser of Fraser Farm Finance. Any decisions made should not be based on this article alone and appropriate professional assistance should be sought.

Don Fraser is the principal of Fraser Farm Finance and a consultant to the Farming Industry. Contact him on 0800 777 675 or 021 777 675. A disclosure document is available on request.